oldfart
Older than dirt
Another thread brought up this point, but I didn't want to hijack it. My question is serious, what reasoning is behind the campaigns for a balanced budget?
Most of these efforts are based on analogy with a household or business. Theoretically a household or business is income constrained and must live within its means, spending no more than it brings in. But this simple notion flies in the face of how households and businesses actually operate. And there is an important difference in that national governments are essentially immortal (as are successful corporations) while households and smaller business are dominated by a life cycle theory of income and spending.
Start with a simple household, one that does not start with any appreciable wealth or debt burden, say an old fashioned college graduate from 40 years ago before student loan debt. In a real sense (but not accounting sense) this household has a pretty good balance sheet, there is a lot of human capital (education) and not much debt. Back then, the first debt most graduates acquired was a car loan. This didn't really change the balance sheet, as the car was an asset and the loan a liability. Cash flow was reduced by the costs of owning and operating the car and transportation services secured. No big deal. Multiple by a factor of ten, and the same process describes the first house/mortgage. My point here is that the education, car, and house are all assets that generate income or necessary services in the future. The debt incurred is relevant only to the extent that the household has to be able to service it.
Similarly, a business incurs expenses for training, recruitment, physical capital, and intellectual property. These expenses create assets, some of which show up on the balance sheet and some which don't. These assets generate future income which hopefully is able to service the debt.
Now in the case of businesses, there are well established accounting rules for defining investment in assets. Some are non-depreciable, some are amortizable intangible assets (like patents, etc), and some are depreciable physical assets. All three are balance sheet items, so that bankers and financial analysts can compute "net book value" of assets minus depreciation and debt, asset-by-asset and at the firm level. We do not consider a company insolvent when the value of its assets exceed the amount of its debt. It gets a little harder applying the same reasoning to a household, but banks do it all the time with financial statements. The borrower adds up the value of all assets, subtracts all liabilities, and the remainder is the borrower's net worth.
But we do not use these concepts in governmental accounting. There is no good register of assets, and some assets are hard to value. Exactly what is an aircraft carrier worth? Or a mile long Interstate highway tunnel? These are clearly public investment, and ought to be accounted for similar to assets of a household or a business; if we are going to use the analogy.
So if we are going to treat government like a business or household, we first would have to account properly for public investments. This has two implications. First, a mere recital of the amount of the public debt is laughably inadequate. What matters for "solvency" is the size of the debt compared to the size of the assets. There have been attempts to do this, and they generally result in an asset-to-debt ratio in the neighborhood of three to one. I will gladly pay off my share of the national debt if I also get my share of the national assets in the liquidation. A few miles of the Natchez Trace Parkway should suffice nicely.
Note that the above exercise only has meaning in a LIQUIDATION. If we are talking about the size of the national debt, this is usually what people mean when they talk about the burden of the debt to future generations. They don't talk about the public goods that go with it. A second meaning that attaches to the size of the national debt is the cost of servicing it. For this it not only matters what the size of the national debt is, but also at what interest rate it is funded at. The relevant figure here would be inflation-adjusted debt service as a percentage of GDP.
So if we set aside the homilies of comparison of government to business and households, what criteria should we use judge the size of deficits and the national debt? A lot of economists have followed Keynes and advocated a modified balanced budget over the life cycle of the business cycle. This means that in downturns the government should run a deficit and in good times it should run a surplus. But why is a zero long-term deficit the magic number?
A second proposal is to look at the cost of servicing the debt and only run deficits that keep the real cost relative to GDP of interest stable. In essence this argues for a perpetual deficit that grows at the same rate as the economy as a whole. But this is also a solution that begs the question of why a steady ratio is desirable, although in the case of many countries (but not the United States) for foreign trade reasons this may be a limiting boundary condition--see Argentina.
A third choice would be to advocate a budget that will achieve a "non-accelerating rate of inflation consistent with full employment". If we go to this standard, it might well be that national debt will grow forever, at least in absolute terms. The roots of this go back to the Employment Act of 1946. The idea is that we set an acceptable upper limit on inflation (right now I would peg this at about 3%), then provide enough stimulus to move us rapidly toward full employment. Note that an unemployed resource generates no income, so any project is marginally better than none; this is a demand-side solution. But if we are a tiny bit brighter, this approach should have a stock of projects that increase public assets which will have a supply-side effect. Maybe it makes little sense to increase spending on research and highways in times of full employment, but it clearly is indicated in times of high unemployment.
Basically I am arguing for deconstructing national income accounts to identify public investment and factoring that into discussions of the national debt and deficit. We should apply the same accounting practices to government that we apply to businesses and households. The goal should not be an arbitrary target for these policies, but rather programs that maximize growth and limit inflation. So, is there a good argument to be made for choosing a zero deficit, or even a stable interest to GDP ratio as a goal? If there is I would like to hear it. But please, don't trot out the tired old analogy again if you can't address the accounting issues.
Most of these efforts are based on analogy with a household or business. Theoretically a household or business is income constrained and must live within its means, spending no more than it brings in. But this simple notion flies in the face of how households and businesses actually operate. And there is an important difference in that national governments are essentially immortal (as are successful corporations) while households and smaller business are dominated by a life cycle theory of income and spending.
Start with a simple household, one that does not start with any appreciable wealth or debt burden, say an old fashioned college graduate from 40 years ago before student loan debt. In a real sense (but not accounting sense) this household has a pretty good balance sheet, there is a lot of human capital (education) and not much debt. Back then, the first debt most graduates acquired was a car loan. This didn't really change the balance sheet, as the car was an asset and the loan a liability. Cash flow was reduced by the costs of owning and operating the car and transportation services secured. No big deal. Multiple by a factor of ten, and the same process describes the first house/mortgage. My point here is that the education, car, and house are all assets that generate income or necessary services in the future. The debt incurred is relevant only to the extent that the household has to be able to service it.
Similarly, a business incurs expenses for training, recruitment, physical capital, and intellectual property. These expenses create assets, some of which show up on the balance sheet and some which don't. These assets generate future income which hopefully is able to service the debt.
Now in the case of businesses, there are well established accounting rules for defining investment in assets. Some are non-depreciable, some are amortizable intangible assets (like patents, etc), and some are depreciable physical assets. All three are balance sheet items, so that bankers and financial analysts can compute "net book value" of assets minus depreciation and debt, asset-by-asset and at the firm level. We do not consider a company insolvent when the value of its assets exceed the amount of its debt. It gets a little harder applying the same reasoning to a household, but banks do it all the time with financial statements. The borrower adds up the value of all assets, subtracts all liabilities, and the remainder is the borrower's net worth.
But we do not use these concepts in governmental accounting. There is no good register of assets, and some assets are hard to value. Exactly what is an aircraft carrier worth? Or a mile long Interstate highway tunnel? These are clearly public investment, and ought to be accounted for similar to assets of a household or a business; if we are going to use the analogy.
So if we are going to treat government like a business or household, we first would have to account properly for public investments. This has two implications. First, a mere recital of the amount of the public debt is laughably inadequate. What matters for "solvency" is the size of the debt compared to the size of the assets. There have been attempts to do this, and they generally result in an asset-to-debt ratio in the neighborhood of three to one. I will gladly pay off my share of the national debt if I also get my share of the national assets in the liquidation. A few miles of the Natchez Trace Parkway should suffice nicely.
Note that the above exercise only has meaning in a LIQUIDATION. If we are talking about the size of the national debt, this is usually what people mean when they talk about the burden of the debt to future generations. They don't talk about the public goods that go with it. A second meaning that attaches to the size of the national debt is the cost of servicing it. For this it not only matters what the size of the national debt is, but also at what interest rate it is funded at. The relevant figure here would be inflation-adjusted debt service as a percentage of GDP.
So if we set aside the homilies of comparison of government to business and households, what criteria should we use judge the size of deficits and the national debt? A lot of economists have followed Keynes and advocated a modified balanced budget over the life cycle of the business cycle. This means that in downturns the government should run a deficit and in good times it should run a surplus. But why is a zero long-term deficit the magic number?
A second proposal is to look at the cost of servicing the debt and only run deficits that keep the real cost relative to GDP of interest stable. In essence this argues for a perpetual deficit that grows at the same rate as the economy as a whole. But this is also a solution that begs the question of why a steady ratio is desirable, although in the case of many countries (but not the United States) for foreign trade reasons this may be a limiting boundary condition--see Argentina.
A third choice would be to advocate a budget that will achieve a "non-accelerating rate of inflation consistent with full employment". If we go to this standard, it might well be that national debt will grow forever, at least in absolute terms. The roots of this go back to the Employment Act of 1946. The idea is that we set an acceptable upper limit on inflation (right now I would peg this at about 3%), then provide enough stimulus to move us rapidly toward full employment. Note that an unemployed resource generates no income, so any project is marginally better than none; this is a demand-side solution. But if we are a tiny bit brighter, this approach should have a stock of projects that increase public assets which will have a supply-side effect. Maybe it makes little sense to increase spending on research and highways in times of full employment, but it clearly is indicated in times of high unemployment.
Basically I am arguing for deconstructing national income accounts to identify public investment and factoring that into discussions of the national debt and deficit. We should apply the same accounting practices to government that we apply to businesses and households. The goal should not be an arbitrary target for these policies, but rather programs that maximize growth and limit inflation. So, is there a good argument to be made for choosing a zero deficit, or even a stable interest to GDP ratio as a goal? If there is I would like to hear it. But please, don't trot out the tired old analogy again if you can't address the accounting issues.
